In financial and Management consultancy, no two days are alike, days only share the light of day and darkness of night. The rest find you as an occupational hazard. It is especially peculiar to say that some of the toughest clients to deal with are the learned lot who they come with the most basic of questions. Take for example a client who checked up on me on Monday morning, Monday blues. “Hey, please point me in the right direction about the stock market. A beginner’s guide sort of thing”. Yeah sounds simple but management has taught me that your answer is only gospel in an academic situation, otherwise a response to a client has to put into consideration the caliber of client that you are dealing with. Yes, it’s no longer a secret that we profile clients. How else can we give you products that blend with your goals?
The standard practice is to ask for the client’s goal. Do you want to earn dividends? Do you want to enjoy capital gains? Speculate and try beat the market through short-term movements? There are several things that you can do with shares. The answer to any of the questions posed to me will always be subjective depending on your profile with a good mix with your goals, both short and long-term.
The first thing you learn about any investment is that you put in money today in anticipation of future cash-flows. Future cash-flows are the tangible financial gains that come as a result of utilizing an asset for economic gain. Any “asset” that has no promise of future cash-flows is not worth your money. It is not a viable investment. Assets with huge underlying future cash-flows attract high initial (investment) outlay as opposed to those with diminishing future cash-flows. Since shares are assets with underlying real businesses, the future cash-flows analysis is done from a firm’s perspective. Does it have a going concern? Is it a monopoly? Does it have competitors? How is the management structure? How is it being affected by changes in technology? In view of the above, you can now figure out why some shares attract relatively more demand. Shares will depreciate in price because they promise little or uncertain cash-flow in future. In other words, the due diligence of the company does not promise a bright future.
The future cash-flow for shares materialize in two ways. Capital gains and dividends. Capital gains comes about when a share appreciates in price due to demand. Again, where does this demand come from? Good. Anticipated future capital gains and dividends by investors of the particular share. Dividend allocation is a company’s way of distributing profits to its shareholders as a return for their capital that was utilized to earn those profits. So, two streams; Capital gains and dividends.
Kindly note (this is important) that on capital gains, you can apply a passive or active approach to grow your wealth. The active approach is what the street calls ‘trading”. These “investors’ try to beat the market through taking advantage of short price movements. They make multiple transactions that unless with a keen eye, you would almost mistake it for gambling. Of course it earns you the margins but it comes at regular transaction costs and relevant taxes so the jury is still out there deliberating on its viability. Alternatively, you can go passive. The passive investor buys for the long haul. These are investors who will bank their dividends cheque, attend AGM enjoy paper capital gains until they have reasons to do otherwise, eg, the future cash-flow prospects are dim. We should do an in-depth analysis on these strategies at different article.
My client is a 30yr old with a young family and a whole future ahead of her, probably 30 more years of economic productivity.
The subjective response I gave my client was the cliché portfolio building. She has a long “economic life” ahead of her and clearly, being a career lady, she doesn’t have time for multiple (trading) transactions to beat the market. Portfolio building is buying shares from different sectors with an aim of diversifying risk and maximizing returns through capital gains and dividends returns over a long period. Five years and above.
To achieve the best returns on a portfolio, the strategy is to perform a proper due diligence on which firms have a profitable economic life in the long-run. Future cash-flows, ditto. Companies threatened by external factors like legal, technological and substitutes tend to have depreciating price of shares and little, far between or no dividends at all. Why? Their future cash-flows have a diminishing pattern. This is followed by spreading your portfolio candidates over different sectors; manufacturing, banking, communication etc. with this behavior, risk is diversified. Observe trend both in price movement and dividend distribution. Some firms are known to give interim and final dividend with a predictable consistency. They come at a higher price but the return on investment is worth it.
Everyone starts from somewhere. When you start building your portfolio today, you won’t believe the load of success that will have your name in 10yrs. It’s a process. Maybe we should talk about portfolio management on another set up. Right? Meanwhile I hope this article gets you started towards the right path.
What’s your dilemma in finance or management? Funny thing is, a client with a different profile would receive a different recommendation. Let us turn your dilemma into knowledge. johnkanjis@gmail.com
